The alleged Italian tax residence of foreign companies

The notion of tax residence applicable to companies is set forth by article 73 of the Italian Tax Code. This provision, in addition to containing a general definition of residency that relies on formal, substantial and temporal requirements, provides for a (rebuttable) presumption according to which a foreign company is deemed to be tax resident in Italy if it controls an Italian company and alternatively (a) is controlled (directly or indirectly) by an Italian company or (b) its board of directors is composed of a majority of Italian tax resident individuals.

In more detail, with reference to the "general" definition of tax residency, according to Italian tax laws, a company is considered resident for tax purposes in Italy if it has, during the greater part of the tax period, i.e. for more than 183 days per year, (i) the legal seat or (ii) the place of effective management (POEM) or (iii) the place where its core business is carried out in Italy. To be deemed as a company resident in Italy, it is sufficient that only one of the above-mentioned conditions is met. Among the three, the most relevant criteria is certainly the "place of effective management", mainly due to its international standing, recognized also at the OECD level, even if the Italian jurisprudence has also always given considerable importance to the place where the core business of the company is carried out.

While it is very simple to identify the "legal seat" of a company, it being a formal requirement which is provided in the articles of association, and while it is relatively easy to verify what the "core business" of a company is, even if this could require some "substantial" reasoning – which could prevail over the formal description provided in the certificate of incorporation of the company – as far as the place of effective management is concerned, this could be difficult to identify especially if its definition differs between the domestic legislation and the one stated in the applicable double tax treaty.

Indeed, since the introduction of the OECD model Italy has made official observations on the former version of the Commentary stating that "the place where the main and substantial activity of the entity is carried on is also to be taken into account when determining the place of effective management of the person other than an individual". In other words, according to the Italian Government, in order to find out in which country the place of effective management is located, it is relevant not only the place where the Board of Directors take their decisions but also, from a substantial perspective, the place where the main activities of the company are carried out.

The OECD definition of "tax residency" for dual resident companies was amended and expanded in the 2017 OECD Model Tax Convention with the addition of other factors that must be taken into account when evaluating the tax residence of a company, further to the one of the place of effective management. The Model now provides that "the competent authorities of the Contracting States shall endeavour to determine by mutual agreement the Contracting State of which such person shall be deemed to be a resident for the purposes of the Convention, having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors".

Having said that, it is worth noting that the Italian Tax Authority and the case law have been giving relevance to all those factual elements which may lead to infer a relationship between the activity carried on by the entity and the Italian territory such as, inter alia, (i) the place where strategic decisions are taken, agreements are made and financial and bank operations are effectively carried out, (ii) the residence of directors and C.E.O.s and (iii) the place where the main administrative and commercial activities and the drafting of all the relevant documentation are carried out. All these principles have recently been restated within Circular letter No. 1 of 2018 of the Italian Tax Police.

With regard to this scenario and specifically to the notion of "tax residency" applicable to holding companies, some good news has recently been provided by the Italian Supreme Court within decision No. 27113 of December 28, 2016. According to the Judges of the Court, the place of effective management of a foreign entity shall be construed in light of the nature of the company. In further detail, the Supreme Court stated that the absence of a relevant organizational structure for a holding company cannot change the conclusion concerning the location of the place of effective management of a company. Under the same line of reasoning, it has also been ruled that (i) restricted operating costs and receivables and (ii) the lack of charges for management services to the subsidiaries cannot affect the analysis of the concept of "place of effective management".

The key message arising from the judgement of the Supreme Court is that the absence of personnel and organizational structure – as in the case of passive holding companies – taken alone are not decisive for the qualification of pure holding companies as conduit vehicles.

The same principles have recently been stated in the case C-6/16 and the joined cases C-504/16 and C-613/16. In the former case the Advocate General of the European Court of Justice pointed out that "an artificial arrangement can be assumed if the company is only a fictitious establishment in the form of a 'letterbox' company [and that] what appears to be relevant is, for instance, the actual authority of the company organs to take decisions, to what extent the company is endowed with own financial means and whether any commercial risk exists". In the latter case the Judges of the Court stated that: "the fact that the economic activity of a non-resident parent company consists in the management of its subsidiaries' assets or that the income of that company results only from such management cannot per se indicate the existence of a wholly artificial arrangement which does not reflect economic reality".

Since the Italian tax legislation relies upon the principle of worldwide income taxation, rather than the mere local one, the level of attention that the Italian Tax Authority and the Italian Tax Police pay to this issue is extremely high.

Furthermore, the assessment of the Italian tax residence of a foreign company could lead to the harmful consequence of potential penalties being imposed on the legal representatives of the foreign entity due to the omitted filing of the Italian tax return. Indeed, the legal representatives of the foreign company may even face criminal charges (ranging from one year and six months up to four years of detention), if the amount of undeclared taxes is higher than fifty thousand Euro.

Other instruments available to the Italian Tax Authority in order to attract in Italy the income of a foreign company

Another domestic provision, which leads to the same substantial result (even if based on different assumptions), is the Controlled Foreign Companies rule, according to which the income accrued by a foreign company controlled by an Italian entity is taxed in Italy notwithstanding its effective distribution.

The decision to conduct the assessment via one provision or the other is usually taken by the officers depending on the level of evidence collected during their investigation. By way of example, when the officers find documentation such as the "headed paper" of the foreign subsidiary at the premises of the Italian headquarters and/or a significant exchange of correspondence (e-mails) between the management of the foreign entity and the Italian one, they would rather challenge the foreign company based on the tax residency principles (although the latter is established in a low-tax jurisdiction without any commercial/industrial activity carried out therein) qualifying it as a so-called "esterovestita".

Notwithstanding the mentioned rules on tax residence, it is also important to consider that the Italian Tax Police, within the recent Circular letter cited above, stated that when the Italian parent company exercises pervasive management powers on the business of its foreign subsidiary, it is possible to qualify the latter as a permanent establishment of the former, with the same substantial result of taxing the overall income of the foreign entity in Italy.

Finally, for the sake of completeness, it is worth noting that the Italian tax authority may also attribute the income accrued by a foreign subsidiary of an Italian company on the assumption that the former qualifies as a "fictitious/conduit" vehicle. This is the case, for example, of a foreign entity located in a tax haven that is not subject to any reporting duty (nor to the mandatory drafting of accounting records and books) and where its "corporate shield" appears to be merely formal.

Given this widespread scenario of possible "weapons" at the disposal of the officers, it is key for any tax manager of a multinational group to, first of all, have a good in-depth knowledge of the Italian domestic and cross-border provisions on the notion of "tax residence" applicable to companies, along with the latest trends in terms of attitude of the Italian tax authority and tax police in relation to its assessment activity, and, secondly, to duly apply those principles when structuring, restructuring or evaluating the "tax compliance" status of a multinational group.

In this respect, in our experience, the abovementioned risk cannot be underestimated also in the case of companies duly structured abroad (such as manufacturing entities) since they could be found to have their place of effective management in Italy. In other words, this is not an issue which is limited to holding or sub-holding companies but it could (and this is the current trend) also hit foreign companies with the relevant number of employees.